The remarkable thing about this extended passage by Tim Geithner is the lack of any acknowledgment anywhere that Larry Summers was, in fact, right in his view: the Obama administration course as of March 15, 2009 was, in fact, putting us on the road to replicating and lost decades. No acknowledgement of that at all…
Tim Geither: Stress Test: “HORSHAM WAS as cold as one would expect of England in March….
I was already run down after months without much sleep…. I caught some kind of flu. On the military plane that took us home Saturday night, I was coughing, aching, and unhappy. The summit had not been a great success…. I had to review materials for a meeting the next day with the President and his economic and political advisers, many of whom were deeply skeptical about our financial repair plans. We would have to make the case for staying the course. I’m not a screamer, but I got a bit loud that night on the phone with Lee and Kabaker, and not just because the reception over the Atlantic was spotty. I was irked by a PowerPoint presentation that they had negotiated with Larry while I was away. The offending slides confronted the hypothetical of a bank that couldn’t raise enough private capital to fill the hole identified by its stress test: What would we do if we had to inject so much TARP capital that the bank was effectively nationalized?
Lee and Larry had agreed to present two options to the President. One was the Treasury plan for a “conservatorship approach,” which would allow us to handle a bank in a way similar to the government’s handling of Fannie and Freddie, so we’d have the discretion to wind down our investments gradually to minimize shocks to the system and losses for the taxpayers. The other was Larry’s “rapid resolution exit,” which would require an immediate restructuring of the bank, including immediate liquidation of bad assets. Both options had their theoretical merits, but I didn’t think Larry’s approach was feasible or desirable. Somehow, though, Larry had talked Lee and Kabaker into making his strategy sound like a cool hawkish approach that would make the President a populist hero, while ours sounded like an equivocating dovish approach that would make the President seem cowed by the banks.
“There’s no way you can present it like that! You’re making the dominant option look pathetic!” I said over the crackling on the line. “You can’t say we’re dove and he’s hawk. There’s no dove. You’ve got to make it Hawk One and Hawk Two!” I was concerned that everyone on board could hear me, including Robert Zoellick, the Republican diplomat whom President Bush had chosen to run the World Bank. I didn’t want to advertise our internal divisions and add to the sense of disarray. But Hawk One/Hawk Two was important. It wasn’t just about framing an arcane debate over resolving failed banks; it was about framing the larger debate about our plan.
Larry and others were suggesting we were shying away from tough choices just as Japan had done after its banking crisis, setting up the United States for a Japan-style lost decade. We thought our strategy was plenty tough. After all, we intended to force big banks to raise the capital they needed whether they wanted it or not. A credible stress test would ensure that the shareholders of the banks that needed the most capital would face the most dilution. The banks least capable of filling their gaps on their own would end up with the largest proportion of government ownership, but even the banks that did manage to raise capital from private investors would dilute the ownership stakes of existing shareholders. I remember once while Larry and I were sitting outside the Oval Office, I tried to convince him that this meritocratic form of triage would be brutal to the shareholders of the institutions that most deserved brutality, while avoiding the panic-inducing consequences of nationalization or liquidation. “I don’t see why you want to portray this as so generous to the banks,” I said. “They’re going to be diluted in proportion to their sins.”
But Larry wasn’t impressed by that argument, and he was a formidable debating opponent. He knew the President liked the idea of firm, decisive action that would end the bailout era and put the mess behind us. He often implied that while the President stood for bold problem solving, I stood for tentative half-measures. At one meeting in the Oval Office, Larry explained that the President was over here, as he extended his arm to his side, while Tim was over here, as he extended his opposite arm. “I’m much closer to you, Mr. President,” Larry said.
ON SUNDAY, March 15, from 3 p.m. until well past 10 p.m., President Obama and more than a dozen of his economic and political advisers discussed our financial crisis response in the Roosevelt Room. Lee and Kabaker had edited their deck to make it clearer that both options were hawkish, but Larry was in classic form, disparaging our strategy as “watchful waiting” for a patient that needed “radical surgery.” Echoing the President’s own words on my first day as secretary, he said the time had come to rip off the Band-Aid and let the system begin to heal. His recurrent theme was that our plan was too reminiscent of Japan, which had kept its zombie banks alive and suffered the consequences of its timidity, and not enough like Sweden, which had nationalized banks and enjoyed a buoyant recovery.
The President was sympathetic to Larry’s views, which some accounts of the Obama administration have used to suggest that he wanted to abandon our plan. “We don’t want to do Japan,” he said at one point. The Roosevelt Room meeting was a spirited debate at a time when I was not exactly at the commanding heights of influence. My team and I spent most of the meeting on defense. The relentless criticism of “Tim’s plan” was a reminder that this all was on me, that even my colleagues inside the administration—led by Larry, who had supported my career since I was his noisy scribe—were unimpressed. The President clearly wanted to hear what disturbed them about our plan, and he let them vent for hours. But we had already announced the outline of our plan. We had launched several specific components of the plan. We couldn’t scrap or dramatically revamp it before we knew the results of the stress test without risking even more turmoil in the markets.
The Roosevelt Room meeting was an opportunity for our colleagues who felt uneasy about the plan to express their criticisms and angst. It was also a chance for the President to get immersed in the debate in case he wanted to adjust our plan down the road. It wasn’t a referendum on whether to proceed. The main policy issue we debated was the Hawk One/Hawk Two hypothetical of what to do if the government needed to take a majority stake in a bank, either before or after its stress test and capital-raising period were complete. Larry and others wanted us to commit to forceful restructuring policies in advance—breaking up or carving up the hobbled banks, replacing management, unloading assets, perhaps even haircutting certain creditors to help cover the losses. My basic response was: Sure, that might make sense in some cases. We’ll see. We couldn’t know what would be optimal months in advance; it would depend on the bank and the state of the world at the time. We couldn’t decide now, and it made no sense to tie our hands.
We were also constrained by the limits of our authority, which didn’t really allow preemptive nationalization. We still had no way to wind down large complicated financial firms, and the FDIC could step in to take over smaller banks only when they were on the verge of failure or technically insolvent under existing regulatory requirements, which none of them were at that point. We were also constrained by the limits of our remaining financial resources. Whatever the possible virtues of a “rapid resolution” strategy, it would be expensive. Hours into the meeting, we got to the last slide in our deck, which noted almost in passing that Hawk Two could require $200 billion to $400 billion in additional capital, more than we had left in TARP.
Rahm practically leapt out of his seat. “What are you talking about?” he said. “There’s no more fucking money!” The last thing he wanted was to force the President to ask Congress for another TARP. The skeptics had a lot of legitimate concerns, but few feasible solutions. Larry and Christy made economic arguments that the banks were in worse shape than we thought. Political advisers made political arguments for more Old Testament justice. Again, my response was: You might be right, and you might get what you want. We’ll see. The results of the stress test would reveal the health of the banks. Their success or failure in raising private capital would determine how tough we would be. We couldn’t responsibly short-circuit the process before we knew how it would play out.
For now, the debate was purely theoretical. It was certainly a theoretical debate worth having. I wanted the President and our internal critics to understand exactly what we were doing. And the President was right: We didn’t want to do Japan. Although it wasn’t entirely fair to Japan, that was shorthand for turning a blind eye to the remaining capital hole in our banking system, for hoping that if we waited around long enough the economy would improve enough for the assets to recover their value and lift the banks out of trouble. That’s what Larry meant by “watchful waiting.” But that wasn’t our strategy. The stress test was the opposite of turning a blind eye; it would subject the banks and their assets to unprecedented scrutiny and transparency. And unlike the early Japanese strategy of “regulatory forbearance,” their see-no-evil approach of letting undercapitalized banks slide, we would make sure banks ended up with enough capital to survive a severe downturn, whether the capital was injected voluntarily by investors or forcibly by us.
Finally, if a bank did turn out to be insolvent, we didn’t intend to follow the Japan model of letting it limp along for years, too weak to lend, dragging down the economy. Our approach to banks that needed another significant dose of government capital, whether it mirrored Hawk One or Hawk Two, would look more like Sweden than Japan.
Among the opponents of “doing Japan,” there was a lot of enthusiasm for “doing Sweden,” shorthand for biting the bullet and nationalizing up front. This affection, however, was based on a bit of myth about what actually happened in Sweden. Lee and Kabaker explained that Sweden had exhausted every other option during the first two years of its crisis before turning to nationalization. Then it nationalized only two of its six major banks—and only after it fully guaranteed the liabilities of its entire banking system to prevent the fire from spreading. Sweden’s banks were also much smaller and less global than ours, at a time when the rest of the world economy was much healthier and the global financial system was much less fragile.
What we tried to push back against was the idea that preemptive nationalization was an appealing option, a cool way to look muscular and advertise our determination to tackle problems. We thought it would be a financial, political, legal, and logistical nightmare. We knew it might eventually be necessary for the weakest institutions. The government had already placed Fannie and Freddie into conservatorship and their CEOs had been replaced. AIG had to replace its CEO, and it was in the process of dramatically downsizing its sprawling businesses. But the notion that we should even consider nationalizing a large swath of the banking system as anything but a last resort, just because it felt resolute and cleansing, seemed irresponsible and unwise. If we nationalized a major bank, we would not only own all its legacy losses and risks, which could be hugely expensive for taxpayers; we would own its management issues and compensation messes and who knew what other surprises. Congress would feel like it owned them, too, and would be tempted to interfere in the bank’s business decisions for political purposes.
Bill Isaac, a former FDIC chairman, had put it well in a Wall Street Journal op-ed that had resonated with me, recounting how the 1984 nationalization of Continental Illinois, a tiny bank by modern standards, had been a terrible mess that lost taxpayer money and dragged on for seven years. Lee compared nationalizing a big bank to invading Iraq. “If you want to go in, you better be sure there are WMDs,” he said. He echoed Colin Powell’s famous Pottery Barn rule: If you break it, you own it.
In other words, before we decided to take responsibility for a troubled bank, we’d better be sure it was truly insolvent. And we thought the best way to judge that was through the stress test. Our critics said we should just take over Citigroup, to signal discontinuity and intolerance for Wall Street excess. That struck me as a rash effort to claim a scalp; we had just orchestrated the share conversion to strengthen the company, going out of our way to avoid taking a majority stake, and Citi was actually starting to show signs of stability…